India's Central Bank Should Maintain Headline Inflation as Policy Target, Experts Advise

External members of India's rate-setting panel advocate maintaining headline inflation as the central bank's policy target, warning against shifting focus to core inflation despite falling interest rates.

External Experts Urge India’s Central Bank to Retain Headline Inflation as Policy Target Amid Rising Food Prices

The central bank's rate council's external members informed Reuters that headline inflation directly impacts Indians and should be maintained as the monetary policy target rather than being replaced by core inflation.

Last month, the government's official annual economic report proposed targeting inflation, except for volatile food prices, which are more influenced by supply shortages. The concept has sparked a discussion in India regarding the appropriate target for monetary policy.

In 2016, India implemented the inflation targeting framework, establishing a headline inflation target of 4% for the central bank's rate-setting commission.

Analysts have been urging the Monetary Policy Committee (MPC) to concentrate on core inflation, which has fallen to record low levels of approximately 3%, as the target has restricted interest rate reduction because rising food prices have maintained headline inflation above 4%.

According to Shashanka Bhide, an external member of the Reserve Bank of India's MPC, evaluating the entire consumption basket is imperative to accurately assess the economy's actual price pressures.

"If we use a partial basket for a target then it would not reflect the overall price pressures and if the target is the core alone, then it should in some way capture the trend of food inflation or fuel inflation if not the volatility," Bhide said in an interview with Reuters.

The MPC, composed of three Reserve Bank of India (RBI) officials and three external members appointed by the government, has maintained the primary repo rate at 6.5% for nine consecutive meetings. The MPC has cited persistently high food prices as a reason.

India's economic growth is anticipated to decrease from 8.2% in the previous year to 7.2% in the current fiscal year.

MPC Members Debate Rate Cuts Amid Concerns Over High Food Inflation and Its Impact on Policy Targets

In an interview with Reuters, Jayanth Varma, a second external MPC member who has voted in favor of a 25-basis point rate cut for four consecutive meetings, said he favors rate cuts. However, he would not provide an opinion on whether the target should

"It would not be appropriate for the MPC to suggest changing the goal post when high food inflation is making it difficult to reach the target," he said.

"One of the key questions for the MPC is whether high food inflation would spill over into core inflation, and this concern would remain if the target were changed to core," Varma added.

Ashima Goyal, the third external member, has also voted to reduce the headline inflation rate for two meetings. She has stated that research has demonstrated that the headline inflation rate in India is moving toward core inflation over the long term.

"Headline is the inflation that impacts the public more. But I think the MPC should pay more attention to core inflation," she said.

The current rate panel has been confronted with headline inflation exceeding the 4% target for most of its tenure due to elevated food and petroleum prices.

Goyal stated that the MPC could have reduced interest rates if it had aimed to reduce core inflation. Varma disagreed, asserting that the core inflation target's numerical value could have been different, rendering it impossible to predict the repo rate with certainty.